Blaming the free market (letter)

by Peter D. Howard

News Weekly, October 2, 2010

Sir,

How unfortunate that Alan Greenspan's confused concession over "too much faith in the self-correcting power of free markets" and "deregulation" should be cited as a sort of mea culpa following the financial meltdown in the United States (John Ballantyne, "The chilling creed of the radical libertarians", News Weekly, August 21, 2010).

Far better reasons for the crisis can be found in the federal finagling going back to President Jimmy Carter's era. The Federal Reserve was created in 1913 by an act of Congress and its chairman was government-appointed. It was endowed with monopoly privileges and with principles opposed to those of the free market because they were dedicated to central economic planning - the discredited idea of the twentieth century.

Economist Larry Kudlow and Wall Street Journal editorial board member Steve Moore point to the Carter-era Community Reinvestment Act of 1977 that purported to prevent denying mortgages to black borrowers - by pressuring banks to make home loans in "low and moderate-income neighbourhoods".

Under the act, banks were to be graded on their attentiveness to the "credit needs" of "predominantly minority neighbourhoods". The higher a bank's rating, the more likely that regulators would say yes when the bank sought to open a new branch or undertake a merger or acquisition. (Wall Street Journal, March 30, 2008).

The debacle of the government-sponsored enterprises (GSEs), Fannie May and Freddie Mac, that bought loans from the banks and often bundled them as mortgage-backed securities for sale to investors, enabled the banks to issue more mortgages, fuelling the inflation of home prices by artificially diverting resources into mortgage-lending.

These are known as sub-prime mortgage securities. Adjustable-rate mortgages, fuelled by people speculating in house purchases and by artificially low interest rates created by the Federal Reserve, were a major factor in defaults as house prices fell in 2006.

Federal intervention, creating a feeling of prosperity, stimulates the boom-bust cycle, resulting in an inevitable crash. The free market is always blamed for that crash.

These artificial booms, wrote economist Henry Hazlitt, must end "in a crisis and a slump". He added: "Worse than the slump itself may be the public delusion that the slump has been caused, not by the previous inflation, but by the inherent defects of 'capitalism'." (What You Should Know About Inflation, 2nd edn, Van Nostrand, 1965, p.18).